31 Aug Economic Market Snapshot – August 2022
Is the ‘bear’ awakening or just rolling over to get more comfortable?
The 2022 calendar year through January to June, global world markets have, in some segments, entered ‘bear territory, with market valuations decreasing > 20%. The market decline has been underpinned by a combination of factors, most notably climbing inflation worldwide, central banks raising interest rates, supply chain delays through Asia and bubbling tensions in the South China Sea, the ongoing Russia/Ukraine conflict and accompanying energy price stocks.
More recently, world investment markets have had a reprieve, with investment earnings particularly out of the US and early signs too in Australia holding up to their longer-term average, with investment valuations clawing back some lost ground.
The question now: Are we leaning into a global recession or a mid-cycle correction?
Following commentary out of the US over the weekend, inevitable talk of recession is growing with the US Central Bank re-affirming the management of inflation as their top priority, suggesting the interest rate rising cycle to continue. Even with an induced recession growing more likely, the economy is not the investment market, with investment markets often running ahead on anticipation and speculation of what may/may not occur.
Our portfolios will not necessarily be immune from volatility shocks that recession fears can trigger, but we have positioned the portfolios for higher inflation for a little while now with a more defensive overview.
Matrix Norwest Asset Management (MNAM) Portfolios
The announcement in January by the US Federal Reserve of the intention to bring forward interest rate rises to combat the then referred ‘transitory’ inflation from early/mid 2023 to 2022 saw a sharp fall in global investment market valuations. Over the course of the last 6 months, we have been moving the asset allocation across all model portfolios to be more defensive, anticipating sustained inflation and the move towards the possibility of recession.Below is a snapshot of the respective model portfolio’s current asset allocation against their strategic asset allocation:
We have achieved our goal of reducing growth asset allocations across all portfolios by most notably selling down long horizon investment managers, both internationally and in Australia. This has been done at regular stages post June capitalising on the valuation tailwinds that now appear to be running out of steam. Proceeds of these sell downs have been directed to cash reserves in readiness for signs of recovery, as well as increased allocations to fixed interest holdings and infrastructure investments, which act as a natural hedge with CPI indexed earnings via rent increases. We have further increased exposure in the alternative asset class allowing the ability to ‘short’ investment markets, identifying those market segments we anticipate having challenging conditions over the next 6 to 12 months and taking positions against those sectors.
The focus moving forward is company earnings, how will investment market corporate earnings hold up under sustained inflation and higher interest rates. Again, we have positioned the portfolios more conservatively on the belief we feel these contracting later in the year and in early 2023.
Thoughts on Australia?
In Australia, where the RBA cash rate is currently 1.85%, we expect this to climb with broad consensus amongst economists being around the 2.5% to 2.75%. With close to 60% of Australian mortgages on a fixed agreement, as these borrowings rollover for renewal, we expect downward pressure of property markets as borrowers find difficulty in refinancing. Over the course of the next 12 to 18 months, we are likely to see declines in housing valuations from the high point of late 2021. A realistic comparison can be made using New Zealand’s recent experience, given they are 3 to 6 months ahead of Australia in the interest rate rising cycle and their property price growth patterns through 2020 and 2021 in capital cities was a similar trajectory to here in Australia, most notably Sydney and Melbourne. Recent valuations indicate a decline in NZ capital cities house prices of between 15% and 20% from their high point.Investment markets in Australia chart very similar to the US, if not slightly lagged from a timing perspective. The Australian share market fell near 10% this calendar year, if anything slightly compensated by the resource sector and a strong banking and financial system. No doubt we will follow the US lead to a point, but challenges globally in the energy sector and the continual push towards clean energy has Australia well-positioned to capitalise over the next decade.
Investment markets typically run ahead of global central bank interest rate announcements and the MNAM Investment Committee believes the necessary adjustments are in place across all portfolios to be more defensive in the near term. Equally, when economic data across the world shows sign of recovery or “green shoots”, we will move quickly to realign with the longer term strategic allocation of portfolios.